Definition: A Stock Split is a method of increasing the number of outstanding shares with a proportionate reduction in its face value. With a split only the price per share reduces, the market capitalization i.e. market value of the outstanding shares and the proportionate ownership interest of the existing shareholders do not change.
The stock split is generally done when the price of a share is too high and is not affordable to all the investors, generally the small investors. Thus, the shares are broken down into multiple shares to infuse the liquidity and to increase its affordability.
Companies split their shares because of the following reasons:
- To reduce the market price of a share and make it more attractive to all types of investors. Generally, the shares with the high market price move into a high trading zone, which is beyond the access of small investors. Thus, a stock split is done to bring the shares into the popular trading zone and make it more affordable.
- Often it is done to convey to the shareholders that firm is expecting higher profits in the future.
- With a stock split, companies do not resort to reducing the cash dividends. Even the investors could earn more dividends if the firm follows a stable dividend policy.
People often get confused with the stock split and the bonus shares. With the issue of bonus shares the issued share capital changes, whereas with a stock split the company’s authorized share capital changes.